Richie Bros. Auctioneers – Trying To Bulldoze The Competition

Richie Bros. Auctioneers (NYSE:RBA) is an auctioneer of industrial equipment. The company is engaged in providing unreserved auction services to equipment buyers and sellers. Ritchie Bros. focuses on the sale of heavy machinery. The company operates through four segments: Core Auction segment, EquipmentOne segment, Mascus segment., and the Private Treaty segment. The Core Auction segment offers a network of auction locations that conduct live, unreserved auctions with both on-site and online bidding. The EquipmentOne segment is a secure online marketplace that facilitates private equipment transactions. The Mascus segment was just acquired in Q1 2016 and is a leading used equipment listing service. Private Treaty was launched in 2015 and is a brokerage channel for highly specialized assets. Richie Bros. sells equipment through unreserved auctions at around 44 auction sites around the world. Through the Company’s unreserved auctions and online marketplaces, it sells a range of used and unused industrial assets, including equipment, trucks and other assets used in the construction, transportation, agricultural, material handling, mining, forestry, energy and marine industries.

Straight commission transactions make up most of the revenue. However, underwritten transactions are a hot topic for the company due to the adjustments in how they approach these transactions. Underwritten transactions accounted for 29% of Gross Auction Proceeds (GAP) in 2015, compared to 31% in 2014, and 28% in 2013. On the surface it is difficult to notice anything different. However, CEO Ravichandra Saligram has emphasized the company’s new controls over underwritten transactions. They will not simply use these transactions to “buy GAP”. Over the last year, RBA has taken a more calculated approach to these transactions and it is paying off. The company is getting away from doing “dumb deals.” It is leveraging its knowledge and experience to ensure underwritten transactions are beneficial to the company. Investors are seeing this methodology flow through to the financial statements with strong revenue growth and higher revenue rates. Revenue rates are calculated by dividing revenue by GAP for the period. This ratio indicates how much of GAP the company is able to convert into revenue. Historically RBA has averaged between 11%-12% but they produced above 12% three out of the four quarters in 2015. I think investors may see the company average 13%-14% in a few years.

Growth and Productivity

During 2015, the company emphasized increased productivity. In Q1 2015, they expanded their training strategy and introduced new leadership training programs for the sales management team. This contributed to an increase in sales force productivity to $12.1 million per revenue producer for 2015, compared to $11.6 million in 2014 and $11.7 million in 2013. Investors hope that they can continue the momentum into 2016. Part of this training included the roll out of the new process for evaluating underwritten transactions which has been effective in reducing losses. The company continues to focus on productivity of existing operations by cutting capex and shifting capital to incentive compensation. They want to reward revenue producers for increasing productivity.

Used Equipment Market

Richie Bros. competes for a $360 billion global equipment market. The market is highly fragmented with many small companies that compete in the online auction market. RBA has shown tremendous monthly active user (MAU) growth on its two established platforms. In 2015, the Core Auction website demonstrated 14% growth on top of a 31% comp last year. EquipmentOne came in with 11% MAU growth on top of a massive 100% comp last year. The macro influences that drive transactions include total U.S. construction spend, U.S housing starts, construction and agricultural machinery manufacturing, and transportation equipment new orders.

According to the Construction Machinery Manufacturing industry outlook report from IBIS World, industry revenue is forecast to rise at an annualized rate of 2.8% in the next five years including a 3.6% rise in 2016. Domestically, the value of residential construction is expected to grow an annualized 5.3% over the next five years. This will facilitate greater demand for construction as new construction takes place.

Growth Strategies

Richie Bros. has several growth strategies it is focused on in 2016. They plan to grow geographies by depth vs. breath. Essentially, they want to dig further into existing markets vs. enter new markets. There is tremendous growth opportunities in Alberta and in Texas going forward. Both of these markets happen to be in the oil patch but they remain incredibly strong. Texas achieved a whopping 30% increase in gross auction proceeds (GAP) in 2015. Additionally, they will focus on growing the transportation and agriculture sectors. Sector diversity will aide the company in being more consistent. Today, 85% of GAP consists of heavy machinery. Due to the lack of diversification, Richie has had ebbs and flows in its business. In 2010 there was a large reduction in new heavy machinery production which weighed on the company in the last couple years. Now that this lack of production has worked its way out of the market, RBA is seeing significant improvement in the age of equipment it sells. Refer to exhibit below:

RBA’s sweet spot in the age of equipment it sells is the 3-5 year range. You can see that dip in 2010 new equipment production showed up in 2013 and 2014. As RBA continues to diversify into different sectors, they will not be exposed to these ebbs and flows. Additionally, Richie is adding additional platforms that cater to different customer needs which will also reduce cyclicality.

New Platforms

The EquipmentOne platform addresses the needs of a customer that wants more control over the sales price, time, and purchaser. This segment showed strong growth with website traffic up 11% in 2015. Going forward, I would expect the EquipmentOne marketplace to be selling equipment from sectors that are experiencing soft pricing at that point in time. This platform will allow sellers to have more control over pricing. Previously, if cosignors wanted to sell equipment, they did not have this option. Their only options were to enter an unreserved auction and hope that pricing firmed up or to not sell the equipment. The Mascus and Private Treaty segments will allow sellers to have even more control over these factors. The collection of Richie Bros. platforms now allows nearly any seller to have an option in selling their equipment. These additional sellers will give GAP a nice tailwind going forward.

Financials

Recent Financial Results

Richie Bros. had a terrific 2015 despite a bland Q4. The company faced substantial foreign currency headwinds throughout the year. However, on a constant currency basis they did very well. Refer to exhibit below:

The organic growth shown in the right column indicates the strong growth the company experienced in 2015. The solid growth in revenue can be attributed to the increase in the revenue rate to 12.14% in 2015 compared to 11.42% in 2014. The revenue rate in Q4 was the lowest of the 2015 at 11.93%. However, that was a seventy seven basis point improvement over Q4 2014. It is clear the company’s productivity initiatives are showing up in the financial results. Investors have to be excited about the improvement in the business operations.

Valuation

The stock is currently trading at an expensive 21x trailing earnings of $1.27. Additionally, the company generates a fair amount of free cash flow but the stock still trades at over 15x the enterprise value. In the above calculation, I obtained growth rates from RBA’s evergreen financial model. This model indicates annual growth targets for a variety of performance metrics. The evergreen model expects RBA to have EPS growth in the high single digit to low double digits. The above calculation assumes a normal growth rate of 9%. I believe this estimate is attainable for the company going forward especially considering the improvement in the revenue rate over the last year.

The calculation above suggests the stock is maybe on the expensive side. Even if the company delivers 13% earnings growth which would be on the high side of their model, I think there would be limited upside if investors buy the stock around $27 today.

Bottom Line

Richie Bros. is a terrific business. I am looking for opportunities to buy great companies at reasonable prices. However, I am not sure that RBA meets this description today. Investors have a lot of things to be excited about but I personally do not want to pay for excessive valuations. I plan on staying patient and hopefully the valuation will become more reasonable in the months to come.